Quantitative Economics, Volume 4, Issue 3 (November 2013)

Public consumption over the business cycle

Rüdiger Bachmann, Jinhui H. Bai

Abstract

What fraction of the business cycle volatility of government purchases is ac-counted for as endogenous reactions to overall macroeconomic conditions? Weanswer this question in the framework of a neoclassical representative householdmodel where the provision of a public consumption good is decided upon en-dogenously and in a time-consistent fashion. A simple version of such a modelwith aggregate productivity as the sole driving force fails to match important fea-tures of the business cycle dynamics of public consumption, which comes out asnot as volatile and persistent as in the data and too synchronized with the cycle.We add implementation lags and implementation costs in the budgeting processto the model, plus taste shocks for public consumption relative to private con-sumption, and achieve a better fit to the data. All these ingredients are essentialto improve the fit. In our baseline specification 50% of the variance of public con-sumption is driven by aggregate productivity shocks.Keywords. Public consumption, aggregate productivity shocks, business cycles,implementation lags, implementation costs, taste shocks, time-consistent publicpolicy.JEL classification. E30, E32, E60, E62, H30.